Q. I hear that tax laws may change dramatically on January 1, 2013. Are there tax strategies that I should consider before year end?
A. Bush-era tax reductions are slated to end on January 1st, unless Congress and the President agree on a way to avoid the “fiscal cliff” before then. Absent such agreement, tax rates will increase for everyone. So, for this year it is perhaps more important than ever to consider your best tax options before year end.
Reverse The Usual Strategy: In years past, the usual advice has been to put off paying taxes for as long as possible. However, with tax rates poised to rise next year, especially for those earning more than $250,000 a year, it may make sense in some cases to reverse this traditional strategy. Here are some specific suggestions to consider:
Postpone Deductions and Charitable Contributions until Next Year: Many taxpayers pay deductible expenses, such as local and state taxes, and make charitable deductions at the end of the calendar year in order reduce their taxes for the current year. However, for this year they may be better off postponing payments until 2013, as doing so could mean that the deductions are worth more next year than they are in 2012.
Realize capital gains this year: Usually, investors postpone selling stock and taking capital gains as long as possible. However, with taxes on long-term capital gains at the historically low rate of 15 percent this year, you may be able to save at least 5 percent by selling stock this year rather than next. (For this reason, it is also possible that there will be a big sell off in stock between now and the end of the year; perhaps that may create a buying opportunity.)
Make Large Taxable Gifts This Year: There has been a lot of discussion about taking advantage of the ability to give away up to $5.12 million tax free this year, since the tax-free gift option could drop to $1 million on January 1st. For those with estates of more than $1 million ($2 million for a couple), who have been considering making large gifts to children in order to reduce the size of their taxable estates, consider doing so this year. That said, this strategy is probably more relevant for individuals with estates exceeding $3.5 million for individuals ($7 million for couples), because President Obama has proposed setting the federal estate tax threshold at these levels going forward. Of course, there is no guarantee where the gift and estate tax thresholds will actually end up.
All of this tax planning is more complicated than ever this year because we do not yet know what the tax rates will be on January 1st. Absent an agreement between Congress and the president, tax rates will increase and hence the above suggestions to “hedge” your tax position. However, you should take tax planning steps only with the assistance of your tax advisor. Given the short time left between now and the end of the year, consult your advisor as soon as possible.